Qualcomm's (QCOM) leadership position for 5G technology just improved significantly since the company and Apple (AAPL) recently agreed to drop all ongoing litigation. The new six year license agreement between the two companies means that Qualcomm will be supplying their Snapdragon 855 modems in Apple's future 5G compatible iPhones. Getting Apple back as a customer will drive strong future growth for Qualcomm.
The agreement with Apple improves Qualcomm's long-term future outlook. That led to the recent sharp 40% increase in the stock price in only a few days. The stock's increase was justified since Qualcomm's modems will be installed in millions of new iPhones in addition to Android-based devices.
The agreement between Apple and Qualcomm led Intel (INTC) to announce that they are exiting the 5G smartphone modem business. This means that Qualcomm has a huge advantage as the go-to smartphone modem supplier. Given these developments, Qualcomm has plenty of growth ahead for 5G technology in the near term and for autonomous vehicles, IoT, and AI over the longer term.
Qualcomm's modems are Faster with Lower Latency than Intel
Apple's iPhones will be better off with Qualcomm's modems. Research by global internet testing and diagnostics company, Ookla shows that Qualcomm's modems are faster with lower latency than Intel's modems. Qualcomm's stronger technical performance is a likely reason for Apple to consider Qualcomm as a supplier again.
The study by Ookla involved over 1 million user initiated tests. The tests confirmed that smartphones with Qualcomm's Snapdragon 845 Mobile Platform had faster cellular speeds and lower latency than smartphones using Intel's XMM 7480 and 7360 modems on carriers, T-Mobile (TMUS) and AT&T (T).
The smartphones equipped with Qualcomm modems beat Intel's modems on every tested metric.
You can see from the chart above that the test results demonstrate Qualcomm's significant performance advantage for smartphone modems. While the test was done using the Snapdragon 845 on 4G LTE, this should give an indication that the more advanced Snapdragon 855 on 5G will also have a significant advantage over the competition.
This is why Apple and Qualcomm resolved their differences. Apple doesn't want to run a future iPhone on 5G with an inferior modem. They want the best performance, which is what Qualcomm offers.
What Will 5G Technology Enable?
The 5th generation of mobile networks known as 5G will enable a variety of new technologies. In a nutshell, 5G will provide faster performance, lower latency, and supports a 100x increase in traffic capacity and network efficiency as compared to 4G. 5G will allow for significantly improved mobile broadband experiences.
5G technology is expected to enable and enhance virtual reality [VR], augmented reality [AR], artificial intelligence [AI], the internet of things [IoT], and autonomous driving [AV]. 5G's high bandwidth, high speed, and low latency will help make VR and AR experiences to appear more natural, thus reducing or eliminating nausea from the motion sickness effect. 5G will also enable multiple 4K and HD video streams, when current technology only provides single streams of video on mobile. This will provide significantly improved experiences.
VR and AR have good uses for gaming, entertainment, education/training, public works/asset management, mental health treatments, emergency management/policing, e-commerce, real estate tours, etc. Research suggests that 5G networks will provide 100x improvement in network efficiency, 10x improvement in throughput, and 10x decrease in latency. Those improvements will help make these applications more effective and enjoyable for users.
The same performance improvements in 5G will improve AI applications. For example, voice activated assistants Siri, Google Assistant, and Alexa will have better contextual awareness with 5G. So, when users ask questions with these programs, more relevant information will be provided. AI will also be intertwined with IoT as connected devices can learn our behaviors and patterns. This can enhance medical patient monitoring and make recommendations for treatment prior to seeing a doctor.
5G will help get us closer to autonomous driving as the technology will allow vehicles to be connected to other vehicles, to traffic lights, to pedestrians with smartphones, to other surroundings, and to the cloud. The speed and reliability of 5G connections will make vehicles increasingly safer since the vehicles will be able to sense more than what humans can by themselves.
Qualcomm makes this AV technology known as C-V2X possible through their 9150 C-V2X chipset. The 9150 enables the low latency and high reliability that is needed for vehicle safety and autonomous driving. Qualcomm's C-V2X chipsets have been undergoing trials by Audi and PSA. While it hasn't been commercialized yet, the 9150 represents a promising future source of revenue for Qualcomm.
Valuation is Fair, But Still Reasonable After the Price Increase
When I first identified Qualcomm for MoSI subscribers, I had a hunch that the company would gain business back from Apple. The reason for that is because Qualcomm's chips perform better as shown earlier in the article.
Now that Apple is back as a Qualcomm customer, the stock price increased over 50% - pricing in some of the future Apple business. However, the current valuation is not too high. The forward PE is currently 16, based on expected EPS of $5.57 for 2020. Those estimates were increased from $4.35 after Qualcomm gained Apple back as a customer.
Qualcomm is trading right at the average of the Communication Equipment industry's forward PE of 16. This is lower than the S&P 500's (SPY) forward PE of 17.7. Qualcomm's stock should be able to increase approximately in-line with earnings growth from this fair valuation level.
Qualcomm is expected to supply 5G-compatible modems for Apple in 2020. This means that Qualcomm will be receiving a boost in royalty revenue of about $2 billion, as the consensus estimates for expected 2020 revenue increased from about $22 billion to $24 billion after the deal with Apple.
Earnings are expected to rise between 10% and 11% in 2019. However, analyst estimates are significantly stronger for 2020 at 36% to 37%. That grow rate is likely to drive further price appreciation from these valuation levels.
The RSI indicator in the chart above shows that the stock is overbought with readings in the 80s. It is difficult to say what will happen in the short term, but some profit taking after the steep run higher would seem natural.
The Chaikin Money Flow [CMF] indicator shows that money flow reached a peak and is declining. This might indicate that a pullback in the stock is coming. The green MACD line reached a high point and looks like it might turn downward crossing through the red signal line. This would reinforce that a pullback is likely in the near term.
Investment Outlook for Qualcomm
The year 2020 is when Apple is expected to use Qualcomm's modems for a 5G compatible iPhone. Even if a 5G compatible iPhone is delayed until 2021, Qualcomm will be receiving royalty payments from Apple.
Qualcomm has proven to be a reliable source of smartphone modems providing strong product performance. That will drive growth for the company for multiple years as we enter the age of 5G technology.
While I wouldn't jump into the stock right now after such a sharp move higher at an overbought condition, I would look for an opportunity to pick up the stock on a pullback on an oversold condition.
Given that Qualcomm is now poised to be a leader in 5G and probably C-V2X technologies, the stock has the potential to double within 5 years on above average earnings growth. Qualcomm's stock would have to average 15% annual growth to double in five years. That looks attainable as that is the expected earnings growth rate over that time period.
I identified Qualcomm for MoSI subscribers as a company with strong growth prospects before the stock increased by over 50%.
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Disclosure: I am/we are long AAPL. Business relationship disclosure: The article was written by David Zanoni with feedback from Kirk Spano.
Additional disclosure: The article is for informational purposes only (not a solicitation to buy or sell stocks). David is not a registered investment adviser. Kirk Spano is an RIA. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.